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California pension planning

July 26, 2013

Old age security by governmental fiat.  That’s what Governor Jerry Brown says he wants to accomplish by requiring that all California wage earners contribute 3% of their income into a state-controlled pension fund.  Presumably, the actual contribution would be augmented at some level by employers, in the same way that employers contribute to Social Security and Medicare on the Federal level. That would certainly help the governor with his cash flow problems for a while.

Let’s see, how has that worked out for folks so far?  Of course the most recognized under-performer in that arena at the moment is Detroit, MI. The city government there has about $3 billion in unfunded pension obligations, as well as $3.4 billion in unfunded health-care benefits, according to an article by Robert Pozen.[1]  A Morningstar chart lists 35 states as having less than 80% of their public employee pension obligations funded in 2011, including California at 77.1%, a drop of 3.5% since 2009.[2]

At any given moment in time, most pension investment funds (and that’s what pension plans are, because the money does not simply grow enough to pay the promised level of benefits through the payment of simple  interest) could show a gap between how much money is available to pay benefits if every single eligible worker were to be paid on a given date, and what is owed.  And it is certainly true that the funds are subject not only to bad investment strategies by their managers, but to national and even global events that diminish the value of the investments on a temporary basis. Anyone with a 401K can see those effects over the past five years, as could any retiree drawing Social Security.

The question is not only will the money you put in be around when you need it, but does the investment firm i.e. the specific entity collecting the money, whether that’s a private employer or a government, have a good track record of managing other money wisely?

The only money you can count on being able to spend is what you have under your direct control. Every pension fund relies on a tremendous amount of faith on the part of the investors that their pension deductions will be well managed and funded at a level that guarantees them the income they were expecting at retirement.  Adding retirement funds of 3 percent to the 7.53 percent the Federal government already deducts will only pay off if you can collect it.

Every pension plan should be on the hook to pay the exact amount of benefits they said they would pay, but no pension fund, not even Social Security, is required to do that.  Technically, once a government gives you a promissory note for your future, you should be able to insist that it is paid in full.  Nice thought, but unlike Bernie Madoff, governments are not jailed nor are their assets confiscated for playing fast and loose with your money.

Despite some very creative bookkeeping and good PR, California is still teetering on the edge of following Detroit. I’d be very skeptical about a California retirement fund, if it becomes law. Ask the workers in any bankrupt city how they think that would work. I don’t think they’d give the idea a great endorsement.

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